A 3-2-1 buydown mortgage temporarily lowers your interest rate by three percentage points in the first year, two in the second, and one in the third, before you begin paying the full note rate in year four and every year after. Someone — most often the seller or homebuilder — deposits a lump sum into an escrow account at closing, and your servicer draws from that account each month to cover the difference between your reduced payment and what the note rate would require. Buyers reach for this tool when rates are high and they’re betting they can refinance before the subsidy runs out.
How the Rate Steps Down
Whatever note rate you lock at closing is the rate on your loan documents. The buydown doesn’t change the mortgage itself; it subsidizes your payments from a separate account.1Fannie Mae. Temporary Interest Rate Buydowns Your effective rate rises by exactly one percentage point per year until it catches up to the note rate, which keeps the payment increases predictable.2Federal Housing Finance Agency Office of Inspector General. Temporary Interest Rate Buydowns Dashboard
On a 7% note rate:
- Year 1: you pay at 4%
- Year 2: you pay at 5%
- Year 3: you pay at 6%
- Year 4 and beyond: you pay the full 7%
What It Costs
The total cost of a 3-2-1 buydown is the sum of every monthly subsidy across the three years, and the whole amount goes into a custodial escrow account at closing as a single lump sum.3Fannie Mae. Guidelines for Temporary Interest Rate Buydowns
Take a $400,000 loan at a 7% note rate over 30 years. The full monthly payment is about $2,661. Here’s what each subsidized year looks like:
- Year 1 at 4%: about $1,910 per month, saving roughly $751 per month, or $9,012 for the year
- Year 2 at 5%: about $2,147 per month, saving roughly $514 per month, or $6,168 for the year
- Year 3 at 6%: about $2,398 per month, saving roughly $263 per month, or $3,156 for the year
Total buydown cost: roughly $18,336. Each month the servicer pulls the subsidy portion from the escrow account and combines it with your payment to make up the full note-rate amount owed to the investor.
Who Pays for It
The seller or homebuilder funds the buydown in most transactions, but the lender, the borrower, or the borrower’s employer can also fund the account.2Federal Housing Finance Agency Office of Inspector General. Temporary Interest Rate Buydowns Dashboard On VA loans, the veteran can fund the buydown directly.4Department of Veterans Affairs. Temporary Buydowns – VA Home Loans
Seller-funded and builder-funded buydowns dominate the market because the arrangement lets a seller attract buyers without cutting the sticker price. That distinction matters when you evaluate a builder’s offer, for reasons covered below.
Whether You Qualify
Every major loan program allows a 3-2-1 buydown, with restrictions, and every program requires you to qualify at the full note rate rather than the reduced rate. The point is to prove you can handle the payment once the subsidy disappears.
Conventional Loans
Fannie Mae permits temporary buydowns on fixed-rate mortgages for primary residences and second homes, but not for investment properties or cash-out refinances. The rate reduction cannot exceed three percentage points and cannot increase by more than one point per year, which makes the 3-2-1 the maximum buydown Fannie Mae allows. The borrower must qualify at the note rate.1Fannie Mae. Temporary Interest Rate Buydowns
Freddie Mac uses a similar framework: purchase transactions on primary residences and second homes are eligible; investment properties and cash-out refinances are not. Borrowers qualify at the note rate.5Freddie Mac. Mortgages with Temporary Subsidy Buydown Plans
FHA Loans
FHA allows 3-2-1 buydowns, but HUD qualifies borrowers at a rate no more than two percentage points below the note rate, no matter what the first-year reduction is. So even though your year-one payment reflects a three-point drop, the lender underwrites you as if the rate were only two points below the note rate. Interested parties can contribute up to 6% of the sale price toward buydowns and other closing costs combined.6U.S. Department of Housing and Urban Development. What Costs Can a Seller or Other Interested Party Pay on Behalf of the Borrower
VA Loans
VA loans allow both 3-2-1 and 2-1 buydowns. The lender must qualify the borrower on the full payment after the buydown ends. VA caps seller concessions at 4% of the reasonable value of the property, and temporary buydowns count toward that cap. The buydown funds must sit in a separate escrow account protected from creditors of the lender, seller, builder, or veteran.4Department of Veterans Affairs. Temporary Buydowns – VA Home Loans
The Seller Concession Cap Problem
A buydown counts as a seller concession, and every loan program caps those concessions. Exceed the cap and the excess gets deducted from the sale price for underwriting purposes, which can unravel the deal.
Fannie Mae’s limits depend on the loan-to-value ratio:7Fannie Mae. Interested Party Contributions (IPCs)
- LTV above 90%: 3% of the sale price
- LTV 75.01%–90%: 6%
- LTV 75% or below: 9%
FHA caps interested party contributions at 6% of the sale price regardless of LTV.6U.S. Department of Housing and Urban Development. What Costs Can a Seller or Other Interested Party Pay on Behalf of the Borrower VA caps seller concessions at 4%.4Department of Veterans Affairs. Temporary Buydowns – VA Home Loans
The VA cap deserves close attention. On a $400,000 home, 4% is $16,000, and a 3-2-1 buydown alone could cost more than $18,000 at current rates. That’s before any other seller-paid closing costs. If the math doesn’t fit, the seller has to drop the price or the buyer has to switch to a 2-1 buydown.
What Happens If You Sell or Refinance Before Year Four
If you pay off the mortgage before the buydown period ends, the funds remaining in the escrow account get credited to the payoff or returned to the borrower or lender, depending on what the buydown agreement specifies.1Fannie Mae. Temporary Interest Rate Buydowns On a VA loan, any leftover funds must be applied to the outstanding loan balance and do not go back to the seller or builder.4Department of Veterans Affairs. Temporary Buydowns – VA Home Loans
If someone assumes your mortgage, the buydown funds keep reducing payments under the original schedule. In foreclosure, whatever’s left in the account goes toward reducing the debt.
The Risks Buyers Underestimate
Payment Shock in Year Four
On the $400,000 example, the payment climbs from $1,910 in year one to $2,661 in year four — a 39% increase over three years. The step from year three to year four adds about $263 per month on its own. Borrowers whose income hasn’t grown meaningfully over those three years feel it right away.
The Refinance Gamble
Many buyers take a 3-2-1 buydown expecting to refinance into a lower rate before the subsidy ends. That plan only works if rates actually fall. If rates stay flat or climb, you’re locked into the full note rate with no exit other than selling the home.
Builder Buydowns and Inflated Prices
When a builder offers a buydown as a sales incentive, the cost often gets baked into the purchase price rather than absorbed by the builder’s margin. You get a lower payment for three years, but you may be paying more for the house than comparable properties would justify. If values flatten, you could owe more than the home is worth, which makes refinancing or selling difficult. The risk is sharpest in new-construction communities where one builder controls pricing and there are few unrelated comparable sales to anchor the appraisal.
3-2-1 vs. 2-1 Buydown
A 2-1 buydown drops the rate two points in year one and one point in year two, then reverts to the full note rate in year three. On a 7% note rate, you’d pay 5% the first year and 6% the second. It costs less than a 3-2-1 because you’re subsidizing two years instead of three and the first-year cut is smaller. It also fits more easily inside seller concession caps, particularly the VA’s 4% limit. The 3-2-1 makes sense when you genuinely need the deeper first-year discount and the seller is willing to fund the larger subsidy.
3-2-1 Buydown vs. Permanent Discount Points
Discount points permanently reduce your interest rate for the life of the loan. One point typically costs 1% of the loan amount and cuts the rate by roughly 0.25%. The savings compound across the full 30 years, but only if you keep the loan long enough to recoup the upfront cost.
The break-even on points is simple: divide the total cost by the monthly savings. If that’s 60 months and you plan to stay eight years, permanent points come out ahead. If you expect to sell or refinance within three to five years, a 3-2-1 buydown concentrates savings in the years you’ll actually be there. Temporary buydowns front-load the benefit; permanent points spread it thin across decades.
Getting It Into the Contract
Two documents do the real work. The purchase agreement should state the dollar amount or percentage the seller will contribute and identify it specifically as funding a temporary interest rate buydown, because vague “seller credits” language can create underwriting problems later. After the lender approves the contract, they prepare a Temporary Buydown Agreement laying out the payment schedule, the effective rate for each year, and the subsidy amounts drawn from escrow.8Federal Home Loan Bank of Chicago. Temporary Rate Buydowns You’ll sign a disclosure acknowledging that your payment will rise each year until it reaches the full note rate in year four.
At closing, the settlement agent verifies the seller’s funds move into the lender’s custodial buydown account before the loan is funded. From then on, you make your reduced payment each month and the servicer tops it up automatically from the account.